Thursday, November 10, 2016

The Government of India has
decided to phase out the existing higher denomination (500 and 1000 Rupees
note) currency from circulation. Many have hailed this decision as an important
step to eliminate black money from the system. At the broadest level, I put
forward a hypothesis that the decision has many possibilities to strengthen the
role of the state. A stronger state has its own consequences on individual
freedom and liberty. This, in turn, has more potential to create an unstable
monetary environment in the long term. Given the distant possibility of a
complete wipe out of black money, there are a few immediate considerations that
are worthy of analysis. Arbitrary and quick decisions from the side of the
government will be carefully observed by the business community. This could lead
to precautionary measures adopted by these groups in future to avoid discretionary
government decisions like the present phasing out.

Arbitrary and dramatic decisions could lead to
distrust in government handling of money supply in the economy. Lack of trust
in fiat currency could have negative impact on the banking system and the
control of credit by the government. Distrust of business in the currency
system, however, could be seen as a positive step towards the rise of newer forms
of decentralised currencies in the country. Online monetary exchanges and
crypto currency would be used for future business transactions. But, the
broader consequence of increase in demand for plastic currency and crypto
currency could be to transfer illegality from paper currency to plastic
currency sector, until the existing monetary institutions are allowed to
undergo positive transformations. Credit and debit card frauds, which are
increasingly reported, are likely to expand. An illegal economy in online
transactions is likely to thrive.

Illegality in currency arose primarily because an
artificial demand was created for paper currency by making it fiat money. The
hypothesis of the current decision was that all the fiat currency and illegal
notes of higher denomination stored in vaults and in circulation will be
affected. The possible surge in demand for lower denomination currency was
predicted and steps taken to deal with it. The heterogeneity of the country,
the differential growth rates of different states, inequalities within these
states, sectoral differences and so on make any analysis of the impact of
policies in India difficult. Different people perceive the impact differently.

An important consequence of wiping out higher
denomination currency is that production in the economy is likely to be
affected in the near term. All activities that were supported and carried out using
illegal money will immediately come to a halt. How the economy copes with this
situation should be speculated. The coping strategies would result in a surge
in the demand for employment. In the absence of development of suitable
employment opportunities, it is likely that the government will find new
avenues to intervene in determining economic opportunities. In other words,
reaction in the business sector would be reflected with a strong rise in the
government sector.

To prevent crime in the economy requires a broader
canvas to determine the origin of the crime. Crime in fiat money originated,
when fiat money was made valuable. This has origins in how the states evolved
and gained control over monetary transactions. Hence, the new policy can be
seen only as a strategic move by the current government, which converted a
long-term problem in the monetary system into a political opportunity. It need
not correct the flaws in the system.

*The Author is Research Consultant at Centre for Public Policy Research. Views are personal and does not represent that of CPPR